1. The World Economy: Trade and Finance by Yarbrough & Yarbrough Copyright © 2003 South-Western/Thomson Learning PowerPoint Presentation Slides prepared by Kerk Phillips Brigham Young University

2. Chapter One Introduction to The World Economy Copyright © 2003 South-Western/Thomson Learning

3. 3 Chapter One Outline 1.Introduction 2.Why study international economics? 3.International interdependence 4.Economic significance of political boundaries 5.Studying international economics

4. 4 Introduction International trade –World Trade Organization (WTO) Emerged as an international forum for trade discussions and conflict resolution. –North American Free Trade Agreement (NAFTA) Trade bloc created in 1995 for USA, Canada, and Mexico. –Trade conflicts & upheavals continue U.S./Japan (photo supplies) U.S./European union (bananas) Asian financial crisis

5. 5 Introduction Macroeconomic dynamics –The world’s stock markets have grown rapidly. New technologies allow fast transfer of funds. –Currencies Japanese yen weakened against the dollar, Most EU countries adopted common currency — the Euro. –Global economic interdependence increased. Nations must be able to withstand external shocks.

6. 6 Why Study International Economics? More important than ever before. –You will be able to fully comprehend statements about international economic policies, evaluate influences on specific industries or companies, and analyze the linkages between your country and other nations of the world. –Most top macroeconomic policy makers of the industrialized world have economic backgrounds.

7. 7 International Interdependence Demonstrated by effects of oil price increases during the 1970s. –In the early 1980s, oil prices declined in response to a policy-induced recession in the developed world. Decline in prices increased the debt problems of developing-country oil exporters (Mexico). This generated financial uncertainty and a loss of export markets for the developed world. –Threatened solvency of several major U.S. banks.

8. 8 International Interdependence In the 1980s, U.S. steel producers sought barriers against cheaper imports. –U.S. automakers had to pay more for steel parts. Their competitiveness declined — they lost market share to imports. –Detroit requested protection against imports. –Voluntary export restraints agreed upon with foreign car companies. –This increased trend for international relocation of much of the world’s auto production.

9. 9 International Interdependence Difficult today to distinguish a product’s “nationality.” –John Deere tractors built in Japan…Komatsu builds in Illinois. –The Ford Escort is assembled in Germany. –Toyotas are built in Kentucky

10. 10 International Interdependence One of the most important recent trends is the increasing involvement of developing countries in the world economy. –Many nations attempted to isolate themselves for many years (China, Brazil, and India) –This trend produces new patterns of international interdependence. For example, manufacturers produce in countries with lower wages.

11. 11 International Interdependence Interdependence in financial markets. –Has grown faster than that in markets for oil, steel, and cars. –24-hour global trading in stocks, currencies, and bonds. Over $1.5 trillion in currencies traded daily. See Figure 1.2

12. 12 Figure 1.2: Daily Turnover in Foreign Exchange Markets, 1986-2001 0.25 Year 19861989 0.50 0.75 1.00 1.25 1.50 1.75 $ Trillions 0 199219951998 2001

13. 13 International Interdependence Global financial interdependence yields opportunities for international investment. –Lenders fund projects regardless of the projects’ locations. –This growth of global trade results in declines in costs of transportation and communication.

14. 14 Cost of a 3-minute phone call New York to London Figure 1.3: Transport and Communication Cost, 1930-1990 (Index 1930 = 100) 0 1930199019401950196019701980 20 40 60 80 100 120 Index (1930 = 100) Year Average air-transport cost per passenger mile Average ocean freight and port charges per short ton of cargo

15. 15 International Interdependence Political Implications –Policy makers must now understand that their decisions in antitrust matters, regulations, and taxes have international ramifications. Firms will make profits in countries with favorable tax laws. Changes in monetary policy or exchange rates in one country might affect many other countries. –Germany’s traditionally tight monetary policy. –Russian, Mexican, and Southeast Asian financial crises.

16. 16 International Interdependence Symptoms of international interdependence. –Rapid expansion of international trade. Since 1950, trade has grown twice as fast as production. Global trade improves individuals’ potential well- being by increasing the quantity of goods and services available to consume.

17. 17 2 4 6 8 10 1950-631963-731973-901990-2000 Output Trade Figure 1.4a: Growth in World Merchandise Trade & Output, 1950-2000 (Percent) 12

18. 18 Figure 1.5b: Growth in World Merchandise Trade & Output, 1950-2000 (Percent) 2 0 4 6 8 10 12 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 World merchandise exports World merchandise output

19. 19 International Interdependence –Countries continue to differ significantly in the extent to which they engage in trade. Large countries like the U.S. tend to engage in less trade (as % of production), than do smaller ones. –Reason? Their domestic markets can efficiently satisfy many needs. –Figure 1.7 shows the marked increase in the U.S.’s global trade in recent years (although it remains relatively small when compared to our GDP).

20. 20 Figure 1.5: Exports and Imports of Goods and Services, 2000 (Percent of GDP)

21. 21 Figure 1.6: U.S. Merchandise Imports and Exports, 1946-2000 ($ Billions)

22. 22 International Interdependence Global trade tends to cluster with certain trading partners. –One reason…lower transportation costs.

23. 23 Figure 1.7: Regional Flows of Merchandise Trade

24. 24 International Interdependence Second symptom of this global interdependence: –Synchronized changes in macroeconomic activity across countries. Tendency toward simultaneous booms and recessions. Cautionary note: perhaps mere coincidence produced these patterns.

25. 25 Figure 1.8 Industrial Production in the Major Industrialized Economies, 1975-1999

26. 26 International Interdependence Most economic transactions between individuals or companies from different U.S. states face a smaller set of barriers than those between a U.S. resident or company and that of a foreign country. National boundaries also help to define each country’s economic policy.

27. 27 Economic Significance of Political Boundaries Major popular misconception about global trade policy is that policy choices pit the interests of one country against those of the other. –In fact, trade policy choices rarely take this form. Trade policy primarily affects the distribution of income within each country. –If U.S. steel producers win protection against Korean producers, then U.S. steel consumers (i.e., auto makers or car buyers) pay higher prices.

28. 28 Studying International Economics International economics usually divided into two parts: –1) Theory of international trade: Expends microeconomic analysis to global questions. –Example: goods and services available to consumers are maximized when each country specializes in producing those goods that it can produce relatively efficiently. Significant political pressure for protectionist policies: Restrict global trade to “protect” domestic producers from foreign competition.

29. 29 Studying International Economics –2) International finance, balance-of-payments theory, or open-economy macroeconomics. Applies macroeconomic analysis to aggregate international problems. Major concerns: –Level of employment and output –Changes in price level, balance of payments, and exchange rates (relative prices of different national currencies). –Interaction of international goals and influences with domestic ones in determining a nation’s macroeconomic performance and policy.

30. 30 Studying International Economics –Open economy One that engages in international transactions. –Closed economy Country that engages in no international transactions.

31. 31 Studying International Economics –Positive models (or analysis) describe the way the world economy works in a simplified way. Focus on explanation and prediction –“If event X happens, then event Y will follow.” –However, there may be disagreement about the way the world works. One individual may think that “if event X happens, then event Z will follow.” Analysts usually resolve such disagreements by conducting further empirical research.

32. 32 Studying International Economics –Normative analysis depends on our judgements about what is and isn’t desirable. If we think that trade is desirable because it maximizes the quantity of goods and services available to consumers, we might conclude that Japanese policy makers should pursue open trade policies in agriculture, even though their farmers strongly oppose them.

33. 33 Key Terms in Chapter 1 International interdependence International investment Economic significance of political boundaries Theory of international trade Protectionist policies Open-economy macroeconomics

34. 34 Key Terms in Chapter 1 Exchange rates Open economy Closed economy Positive analysis Normative analysis